Should this family move to the U.S.?

More families are dealing with mid-life career changes and cross-border moves.

That’s why the 2013 IAFP symposium case study, presented last month in Ottawa, examined the potential cross-border tax, retirement and estate planning issues of a hypothetical family from Ottawa.

The father’s job is in jeopardy and the mother is being asked to accept a work transfer to the U.S. Meanwhile, the couple has to amp up retirement saving, while also providing for their kids’ educations.

The case was based on real client examples, says Peggy Cameron, an IAFP symposium committee member and founder of Cameron Leadership Development in Ottawa. It shows advisors how to balance short-term, retirement and family goals simultaneously.

Read: Clients buying U.S. real estate? Consider trusts

Case study details

Jim, 42, and Sarah, 40, live in Ottawa (in a $400,000 jointly owned home) and have three children, with ages ranging from 10 to 17. One was born with a heart condition, and has regular checkups at an Ottawa hospital.

The couple makes more than $295,000: Jim works with the Federal Public Service and makes $95,000 a year, while Sarah is a computer engineer at Cisco who brings in $200,000 a year, plus a 35% annual bonus. The children go to private school for a total cost of $30,000 per year—that cost is expected to rise by 10% in 2014.

As for savings, Jim and Sarah each have an RRSP and TFSA invested in mutual funds, and they have a family RESP and a joint non-registered investment account that are also invested in mutual funds.

They also have life and disability insurance. Additionally, Jim has a pension and Sarah has $600,000 in Cisco stock options.

The issues

Jim may lose his job due to downsizing. Meanwhile, Sarah’s company is consolidating in Austin, Tex. and she’ll likely lose her job if she doesn’t move.

The couple’s considering these three options:

• They can stay in Ottawa and invest in a medical technology startup run by doctors at the Ottawa Heart Institute, with Jim staying in his current position (as long as it exists).
• They can move to Alberta, where Sarah can join another friend’s 7-year-old company and Jim can request a lateral move.
• They can relocate to Texas, where the company will take care of the family’s green cards. Jim’s employment would be uncertain.

Sarah’s salary makes up more than half the household income. In comparison, her starting salary at the Ottawa company would be $80,000 (with staged increases). Her Alberta pay and benefits haven’t yet been determined.

At first blush, moving to Texas makes the most sense, especially because there are no personal income taxes in that state. There are federal taxes, however, says Shawn Brayman, CEO of PlanPlus in Lindsay, Ont.

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Based on their current finances and employment, he finds they’d save nearly $50,000 on taxes by moving to the U.S., since they wouldn’t have to pay personal income taxes. Their marginal household tax rate would fall from 43.97%, or $126,191, to 33.22%, or US$80,501 (about CDN$83,000).

This analysis assumes Sarah’s salary remains the same and that Jim finds a new job that offers a salary of US$95,000. If he lost that salary or had to accept reduced pay, however, the family would have to reevaluate their tax situation.

Income Tax Summary – Canada
Jim’s Tax	$24,745
Sarah’s Tax	$101,446
Total Taxes	$126,191
Jim’s Marginal Tax Rate	43.40%
Jim’s Average Tax Rate	26.04%
Sarah’s Marginal Tax Rate	44.17%
Sarah’s Average Tax Rate	36.28%

Income Tax Summary – Texas (all figures in $US)
Jim’s Tax	$14,959
Sarah’s Tax	$65,542
Total Taxes	$80,501
Jim’s Marginal Tax Rate	28.00%
Jim’s Average Tax Rate	15.74%
Sarah’s Marginal Tax Rate	35.00%
Sarah’s Average Tax Rate	23.44%

On the upside, sales taxes are lower in Texas (8.25% compared to 13% in Ontario), and land taxes (between 1.9% and 3.1% in Austin) are tax deductible, says Terry Ritchie, director of cross-border wealth services at Cardinal Point Wealth in Calgary. The family could also buy a home for half the price of their $400,000 Ottawa home (the median price in Austin is US$227,400). If they move, Sarah must ensure she negotiates a favourable compensation package, as well as find out how her stock options might be affected. In particular, she should ask for benefits that would help cover their daughter’s medical needs, says Brayman.

Read: One Canadian retirement advantage

Trouble with registered accounts

The family must deal with their RRSPs if they move to Texas. Such plans aren’t sheltered in the U.S., but Brayman and Ritchie suggest the couple keep their accounts if they move. They’d face high taxes if they withdrew their RRSP funds prior to moving. Jim would have to pay withholding tax of 10% on his $11,000, while Sarah would have to hand over 30% of her $200,000. Plus, the couple would have to pay extra taxes at filing time, since their marginal tax rates exceed those withholding rates.

Also, they’ll need their registered accounts if they ever move back to Canada. Their RRSPs make up a significant portion of their planned retirement income.

If they chose to keep their RRSPs, they’d need to file Form 8891 to the IRS to defer any U.S. taxes payable, says Ritchie. They’d also have to file Form 8938, which must be completed by families or people if the value of their assets surpasses reporting thresholds. Thresholds differ for Canadian residents living in the U.S. and U.S. residents living in Canada, he adds. Jim and Sarah, who are filing jointly, would have to file the form since their collective foreign assets are worth more than $100,000.

Read: Faceoff: TFSA vs RRSP

Attaching these forms to their joint U.S. tax return would protect them from paying tax on any RRSP income, adds Brayman. The only potential downside of keeping their accounts, he adds, is they won’t be able to manage their investments as easily from the U.S.

However, SEC rules allow U.S. broker-dealers to manage clients’ RRSPs and RRIFs if they meet certain exemption requirements. For example, brokers can’t advertise those products to other clients, and they have to disclose that the vehicles aren’t fully regulated in the U.S.

If the couple makes withdrawals while in the U.S., Ritchie says, the IRS will only tax the income portion of the funds used based on the level of “accrued income [generated] since the point of U.S. residency.” To avoid high U.S. taxes, they could “resell all their [appreciated] RRSP assets to up the capital portions of their accounts, and thus lower the income portions,” says Ritchie. “This creates a new capital base for the [purposes of] U.S. taxes.” But Jim and Sarah would still be subject to Canadian withholding tax of up to 25%.

“There are two levels of withholding that can be imposed. First, there’s the option of 15% tax if the withdrawal is defined as a periodic distribution that is lower than 10% of the RRSP value, or lower than two times the tabled RRIF distribution amount,” says Ritchie.

If withdrawals exceed those levels, or are lump sums, people are hit with the 25% tax rate. On the bright side, the couple could get a foreign credit on Canadian taxes by filing Form 1116 to the IRS. That form can be used by international mutual fund investors.

Read: 5 tips to help cross-border clients

Unrecognized registered assets

Unfortunately, TFSAs and RESPs can’t be sheltered when people move to the U.S. They’re aren’t part of the Canada-U.S. tax treaty. As a result, Jim and Sarah should withdraw the money from their TFSAs if they move to Texas, says Ritchie. He often advises clients to either put the funds toward moving expenses or new homes, for example, or suggests they transfer the money to other accounts.

Unfortunately, the couple’s RESP couldn’t be collapsed easily. So, the family’s $100,000 plan would likely stay intact and would be taxed the entire time they lived in the U.S. Ritchie adds Jim and Sarah would be required to file extra forms during their stay since the IRS considers RESPs as foreign trusts.

Their 17-year-old son would be the first to pay tax on withdrawals, but he can search for U.S. tax credits. U.S. schooling would cost more than $20,000 per year, says Brayman, based on current average tuition and residence costs.

The couple would also need to continue saving for the other kids. People can contribute to 529 plans in the U.S., which are managed by each state. These don’t offer access to grants like RESPs, however, says Ritchie, and few people use them. Brayman suggests the family would benefit from reducing spending, especially if Jim has trouble finding a job after moving. They could send their two youngest to public school, for example, and put the money they used for private school toward post-secondary expenses.

Lastly, Jim and Sarah must consider how their $18,000 non-registered account would be treated if they leave Canada, says Ritchie. “When you leave, any non-registered accounts are deemed sold at fair market value, and there would be capital gains tax.”

Read: Should this go in my RRSP?

Company savings

Since Cisco is consolidating in Texas, Sarah’s company stock options are likely U.S.-based. But whether or not she relocates, she’ll need to file Canadian tax returns if she exercises her options because they “were granted while she was living in Canada,” says Ritchie.

But she could get a foreign tax credit in the U.S. for any Canadian taxes paid on her gains. Brayman adds her advisor would have to consider the strike price and terms of her stock options when planning how they fit into her overall portfolio. Before Jim moves, he could transfer his $325,000 government pension to a locked-in RRSP or a deferred annuity that he’d receive starting at age 60.

There would be no immediate tax consequences to choosing an annuity. If the funds are moved into an RRSP, though, Ritchie says they should be invested in U.S. assets so the family has access to U.S. dollars while living in Texas. They’ll need to defer taxes on that RRSP as well, he adds, and the account would have to be included on the family’s U.S. foreign bank account report, or Form TDF 90-22.1. This is “similar to Form 8891 and Canada’s T1135, and is filed separate from their U.S. tax return.”

Ritchie favours the locked-in RRSP over the annuity because then Jim can invest the funds as desired and determine how he’ll stream his retirement income.

Jim’s severance pay (worth 21 weeks’ salary) would be treated much the same way; he can leave it with the government and take it when he retires, or drop it into his RRSP, which has $10,000 of room for 2012, says the study.

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Returning to Canada

If Jim and Sarah move to Texas, they’ll likely build U.S. savings through IRAs and 401(k) plans.

Lucky for them, Canada allows people to roll funds from these accounts into RRSPs whether or not contribution room is available. “But clients have to pay 15% withholding tax,” says Ritchie, and people should only roll funds over if they don’t plan to return to the U.S. This is especially the case for those who have held green cards rather than work visas. “If [people have] held green cards for more than eight years, they have to pay up to 30% income tax on deferred compensation when giving their cards up and transferring funds from U.S. registered accounts. That’s due to expatriate tax laws, which apply if, upon departure, someone’s net worth exceeds US$2 million, or if her five-year average income tax liability exceeds $139,000,” says Ritchie.

People are also treated as if all of their assets have been liquidated. It’d be best for Jim and Sarah to keep their green cards, since they’d avoid substantial taxation upon return and keep their U.S. options open. This way, they could choose to reside in the U.S. again, and their kids could choose to stay. Holders must return to the States at least once a year or they risk being accused of abandoning their cards. Under proposed immigration laws, they could then be barred from living or working in the U.S., says Ritchie.

If Jim and Sarah keep their cards and U.S. accounts after returning to Canada, they’d need to file Form T1135 to CRA each year to disclose their foreign income.

Read: IIAC calls new T1135 impossible

Case study details

Here are Jim and Sarah’s finances:

Assets

› Jim’s RRSP has $11,000 (mutual funds)

› Sarah’s RRSP has $200,000 (mutual funds)

› Family RESP has $100,000 (mutual funds)

› Jim’s TFSA has $10,000 (mutual funds)

› Sarah’s TFSA has $15,000 (mutual funds)

› Joint account, open investments, worth $18,000 (mutual funds)

› Joint savings, everyday operations, has $6,000

› Sarah has vested stock options with her company worth $200,000, as well as unvested options worth $400,000 that will be unlocked in 2017

› Jim has a severance package worth 21 weeks of pay that he can claim now or when he retires

› Jim also has a pension that’s currently worth $325,000. He can transfer it to an RRSP or gain access to it via a deferred annuity at age 60

› Sarah receives $800 a month in child support payments for her son, which are expected to last until he finished post-secondary school

› Jim has group life insurance with the federal government that’s worth twice his annual salary (that value diminishes starting at age 65)

› Sarah has UL life insurance worth $300,000 (it has a cash value of $5,500 and her annual premiums are $3,500)

› She also has STD insurance worth 66% of her present salary for two years, and LTD coverage worth 40% of her salary until she’s 65 years old

› Jim is settling his parent’s $500,000 estate and he’s entitled to half

Liabilities

› They owe $4,500 on their line of credit

› They have a fixed-rate mortgage of $100,000, which is coming due in July 2015

Family issues

Sarah’s son Jonathan is from her first marriage. Since she stands to receive child support payments for the next eight years, Sarah would need to know if she’d still receive the funds if the family moves. Also, her ex-husband will need to accept any moves. She’ll have to speak to a lawyer.

Further, Jim and Sarah’s daughter has a heart condition and may require major surgery when she’s older, so Sarah and Jim must consider how they’ll pay those costs if they move to Texas.